From late December to mid-January, airline stocks made another move higher, thanks to expectations of another banner year in 2014. It’s been quite a run for the major carriers such as Delta Airlines (NYSE: DAL) and United Continental Holdings (NYSE: UAL), which have surged more than 600% and 900%, respectively, over the past five years.

#-ad_banner-#Credit goes to an investor willingness to stop worrying about the next industry bankruptcy. These carriers are now much more financially stable, and the era of booms and busts has likely passed. Share prices no longer deserve to trade at four or five times trailing earnings, which had often historically been the case. Both of these carriers now trade for more than 10 times this year’s earnings.

Yet headwinds are beginning to gather for this industry, and United is especially vulnerable.

In recent weeks, analysts have been trimming their profit forecasts for the company, mostly due to a large number of flight cancellations as the nation endured a deep freeze. Three months ago, analysts had assumed that UAL would lose $0.36 a share in the current quarter, which is seasonally weak. But the carrier told investors that bad weather has had a deep impact, and the consensus forecasted loss has been pushed to nearly $1 a share.

Analysts must assume that UAL will make up for lost time over the next three quarters, as full-year profit forecasts have actually risen by roughly $0.25 over the past 90 days to around $4.30.

Yet these analysts appear to be overlooking a key problem for United and other carriers: Jet fuel prices could soon be on the rise as refiners pass on higher crude oil costs. West Texas Intermediate crude oil (also known as light, sweet crude) stood below $95 a barrel in mid-January but has recently surged above $100.

Where oil prices go from here depends on China, and that country’s economy can impact UAL in one of two ways.

If China is poised for another year of solid economic growth, then rising economic activity in the U.S. and Europe could start to boost demand for crude oil, sending prices ever higher as we saw back in 2007, the last time that the developed economies were steadily growing.

How much does a change in jet fuel prices impact United? Consider that the carrier saved almost $600 million last year (representing more than half of its $1.1 billion adjusted profit) as its average cost for jet fuel declined by $0.15 to $3.12 a gallon.

Said another way, a $0.15 move in jet fuel prices could negatively impact EPS by roughly $1.50. The carrier has likely hedged some fuel prices, but doesn’t divulge specific data. But in effect, if crude oil prices moved up to $110 a barrel, much of United’s profits would dry up.

If the opposite scenario plays out and China’s economy is headed for a slowdown (stifling the economies of all its Asian trading partners as well), as some recent data suggest, then United would feel the impact disproportionately.

Merrill Lynch notes that the carrier has “high exposure to non-Japan Asia,” with a leading market share in China as a key focus for the carrier (though rivals are rapidly adding capacity in China, creating tougher competition).

Merrill Lynch’s analysts think the Street is wrong in assuming that EPS can exceed $4 this year and $5.50 in 2015. Citing “labor cost pressures in 2013 and 2014 and elusive revenue synergies,” they see 2014 EPS of just $3 and 2015 EPS of $4.10. Their $28 price target reflects 40% potential downside.

They make no mention of changing fuel prices, yet you can be sure that they and other analysts will need to trim their profit outlooks if crude oil prices stay above $100 and higher jet fuel prices become the norm.

Shares are unlikely to quickly fall to Merrill’s $28 price target, but as investors start to better understand the emerging headwinds for UAL when first-quarter results are released in late April, they may look to lock in profits.

Assuming Merrill is too bearish and UAL instead earns around $3.60 this year (roughly splitting the difference between their view and the consensus), then shares are worth no more than 10 times projected 2014 profits, or around $36 a share. That represents 23% downside from current levels.

Action to Take –>
— Short UAL at prices down to $42
— Set stop-loss at $50
— Set initial price target at $36 for a potential 14% gain in six months

This article was originally published at ProfitableTrading.com:
This Huge Gainer Looks Headed for a 20%-Plus Sell-off